Wednesday, January 14, 2009

Financial Crisis Hits Home-Loan Banks

The Federal Home Loan Bank of Seattle said it expects to fall short of one of its capital requirements because of a continuing drop in the value of certain mortgage-backed securities.
The warning is the latest sign of the risk that the federal government may have to prop up some of the 12 regional home-loan banks, a vital source of funding for thousands of banks across the country, particularly small, local institutions. In September, the Treasury established a credit facility for the home-loan banks in case they have trouble raising money through their regular global debt sales. So far, they haven't tapped that Treasury line.
It's "quite possible" one or more of the home-loan banks will need to use the credit line, said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a research firm in Washington.
Chartered by Congress in 1932, the home-loan banks are cooperatives owned by more than 8,000 commercial banks, thrifts, credit unions and insurers. They make loans to the institutions that own them, with collateral frequently consisting of home mortgages or related securities.
Investors generally assume the U.S. government would rescue the home-loan banks in a crisis. As a result, they have long borrowed on favorable terms in global bond markets. Their funding costs have risen recently as investors shy away from all kinds of risk, however. As of Sept. 30, they had combined borrowings of about $1.3 trillion, making them one of the world's biggest debtors.
The Seattle bank said it is likely to fall short of its risk-based capital requirement as of Dec. 31, 2008. The Federal Housing Finance Agency, or FHFA, which regulators the home-loan banks, requires them to hold capital sufficient to cover estimated credit, markets and operations risks.
Home-loan banks that fall short of capital requirements are barred from paying dividends or buying back certain kinds of stock. That can crimp the finances of local banks that depend on the dividends or want to redeem their stock in the home-loan banks. Because of previous financial woes, the Seattle bank hasn't repurchased Class B stock since 2004 and recently announced it wouldn't pay a dividend for the fourth quarter. Some other home-loan banks also have restricted repurchases of stock to preserve capital.
In all, the 12 home-loan banks own $76.2 billion of so-called private-label mortgage securities, those not guaranteed by Fannie Mae, Freddie Mac or the U.S. government, according to Moody's Investors Service. As of Sept. 30, the banks had recorded $13.5 billion of unrealized losses on these securities. That compares with total capital at the banks of $57 billion as of that date.
The banks generally argue that they plan to hold these securities until maturity and don't expect huge losses on them. But accounting rules require them to mark the securities to current market value at a time when very few investors are willing to buy private-label mortgage securities. If the drop in value is deemed "other than temporary," the banks need to record losses that eat into their capital.
Write to James R. Hagerty at bob.hagerty@wsj.com